Europe needs faster growth, not just the ‘confidence fairy’

The European Commission is forecasting more of the same: the region’s economies will continue to grow at a slow rate, albeit with some welcome mild acceleration, both this year and next.

Much has been made of the apparently cautious forecasts for Ireland: at 1.8 per cent, the expected expansion of GDP is slower than the Government and other prominent soothsayers have been suggesting. But the differences between these various forecasts are not, in reality, that significant.

I suspect the commission did not want to give any encouragement to the notion that things are improving so quickly that the Government here can now contemplate tax cuts. More likely, the Eurocrats are worried that the fiscal consolidation process still has much further to run, here and elsewhere, and so it is important to keep the pressure on. One of the many lessons of the last few years is that most governments throughout Europe are incapable of serious economic reforms, of any kind, unless faced with acute crisis.

Curious discussion
Indeed, the commission's winter forecast contained the usual calls for further structural reforms. These come in many shapes and sizes and are not just a thinly disguised call for further austerity (although they are that as well). In a curious, if somewhat odd, discussion of the risks around their central forecasts, the commission thinks that the biggest likely source of problems is a sudden loss of confidence sparked by backsliding in the pace of reforms.

This is an explicit statement of belief in the idea that austerity has its positive effects via improved consumer and business confidence. Correspondingly, the upside risks lie with the possibility that accelerated reforms produce even more of an uplift in confidence.

This is all rather inward-looking and stems, I suspect, directly from Olli Rehn, the commission's vice-president in charge of all this. He has undoubtedly been stung by the many critics of austerity, not least Paul Krugman, who coined the term "confidence fairy" when describing the intellectual flimsiness of austerity's rationale.

'Confidence fairy'
Mr Rehn seems to think the appearance, or disappearance, of the confidence fairy is the main determinant of Europe's growth prospects.

Any assessment of risk is usually subjective. Spontaneous waxing and waning of confidence levels may indeed have an impact. The spontaneity bit of the argument is probably the most contentious part of all of this: confidence usually has a cause, as well as an effect.

In any event, we in Ireland might think that Europe’s flirtation with deflation is a bigger risk. If there is a home-grown catalyst waiting to reignite the euro zone financial crisis, deflation has to be high up on the list of suspects. If we get deflation, it will involve a wealth transfer from debtors to creditors. In effect, a further impoverishment of the periphery to the benefit of the core countries. That is unlikely to last long or end well.

Speculative attacks
The other risk lies in the nature of the commission's forecasts. All growth is welcome and the 0.1 percentage point rise in growth forecasts compared with last time is important. It is, of course, just about the smallest such forecast revision. But for as long as growth expectations are stable or rising, there will be no speculative attacks on the euro. Indeed, there are plenty of speculators willing to own the euro and peripheral bond markets while things stay as they are.

But those same hedge funds are more than capable of reversing those positions once a suitable catalyst arrives, most likely a change for the worse in growth expectations.

Dark side
Growth is good but there is a dark side and it comes from the weakness and fragility of that growth. The rise in anti-EU sentiment around the Continent is striking. It has many causes but sluggish economies with associated high unemployment rates are feeding a general malaise that is benefitting parties who are often europhobic.

Nowhere is this more worrying, or obvious, than in France, where opinion polls suggest a sharp rise in those who would, for example, like to restore the franc. It is clear that mainstream politicians in France are very worried by all of this. I suspect that Olli Rehn is as well. Europe needs faster growth than he is currently forecasting.